Generally, ASC 740 requires that the tax effects of changes in tax laws or rates be recorded in the period of enactment. The enactment date is the date the president signs the bill into law. As a result, with President Trump signing the CARES Act into law near the end of the first calendar quarter (27 March 2020), the changes must be recorded in the first quarter of 2020 for calendar year corporations (and the relevant quarter for fiscal-year corporations).
Net Operating Losses
After the enactment of the Tax Cuts and Jobs Act (“TCJA”) in 2017 and prior to the enactment of the CARES act, corporations could carry a net operating loss (“NOL”) only forward, not back. The carryforward period was indefinite (as compared to 20 years prior to the TCJA), and an NOL could only offset up to 80 percent of taxable income (a limitation that was introduced in the TCJA). The NOL carryforward created a deferred tax asset for a corporation equal to the amount of the NOL carryforward multiplied by the 21 percent US corporate income tax rate. A valuation allowance was recorded based on the portion of the deferred tax asset for which it is more likely than not that a tax benefit would not be realized by the corporation. In order to realize the tax benefit of an NOL carryforward, a corporation needed sufficient taxable income within the carryforward or carryback period under the tax laws.
The CARES Act provides corporations a five-year carryback for NOLs generated in taxable years beginning in 2018, 2019 and 2020. FASB has identified four sources of taxable income that may be available under the tax laws to realize a tax benefit for net operating losses. One source is taxable income in a prior carryback year if a carryback for an NOL is permitted under the tax laws. This source of income became irrelevant (for US purposes) for an NOL after enactment of the TCJA. With carrybacks now permitted for NOLs arising in 2018, 2019 and 2020, taxable income in a prior year is relevant in determining whether a valuation allowance is needed against a deferred tax asset established as a result of an NOL.
A corporation that has recorded a deferred tax asset for an NOL arising in 2018 or 2019 that will be carried back to a pre-2018 year pursuant to the CARES Act will record a tax benefit because the resulting carryback refund will be measured at the 35 percent rate versus the 21 percent rate at which the deferred tax asset had been measured before the CARES Act. An NOL created in 2020 that will be carried back to a pre-2018 year should be recorded at a 35 percent rate.
In taxable years before 2021, NOLs may be utilized in such years without regard to the 80 percent of taxable income limitation. This may affect the determination for the recording and amount of a valuation allowance.
There may be interactive effects between the NOL rules and the global intangible low-taxed income, foreign-derived intangible income and base erosion and anti-abuse tax provisions. Such effects would need to be considered in determining the ASC 740 implications.
Section 163(j) Business Interest Expense
After the enactment of the TCJA and prior to the enactment of the CARES Act, corporations (and partnerships) could only deduct business interest expense equal to the sum of business interest income, 30 percent of adjusted taxable income (“ATI”) and floor plan financing interest. Any business interest expense disallowed as a deduction is carried forward to the next year. For purposes of ASC 740, any disallowed business interest expense that is carried forward results in the recording of a deferred tax asset (equal to the carryforward amount multiplied by 21 percent corporate tax rate). Some corporations have established a valuation allowance concluding that it is more likely than not that a tax benefit will not be realized by the corporation. See Emily L. Foster, Financials Reveal Hazards of Interest Limitation Deduction Rules, 166 Tax Notes 1799 (Mar. 16, 2020).
As part of the CARES Act, congress temporarily increased the percentage limitation of deductible business interest expense from 30 percent to 50 percent of ATI. The increased percentage is only applicable for taxable years beginning in 2019 and 2020. A corporation may elect to use its 2019 ATI in lieu of its 2020 ATI in determining its deductible business interest expense for the year. The higher percentage may reduce the business interest expense carryforward and therefore the corresponding deferred tax asset. A corporation may also need to redetermine its valuation allowance (if any) that it has recorded. In addition, to the extent the additional business interest expense deduction results in an NOL for that tax year, it could result in a carryback (or larger carryback) of NOLs to a 35 percent tax year.
Qualified Improvement Property
As part of the TCJA, Congress eliminated the separate definitions of qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property, and provided a general definition of qualified improvement property (“QIP”). Congress intended QIP to be depreciable property with a recovery period of 15 years. By having an applicable recovery period of 20 years or less, QIP would be “qualified property” under Code Section 168(k) and thus taxpayers could immediately expense the cost of QIP through their 2022 taxable year.
In the TCJA, Congress defined qualified improvement property, but failed to include the 15-year recovery period for it. As a result, immediate expensing was not available.
As part of the CARES act, congress included a technical correction providing a 15-year recovery period for QIP with an effective date retroactive to the date of enactment of the TCJA. The technical correction may allow for recognition of a tax position taken in a prior period that did not previously meet the more-likely-than-not recognition threshold. To the extent the expensing of QIP results in an NOL for that tax year (2018, 2019 or 2020), it could result in a carryback (or larger carryback) of NOLs to a 35 percent tax year.
